The Federal Opposition is selling it as a plan which affects less than 10 per cent of Australians, as most of the benefits flow to self-managed superannuation funds (SMSFs), and may save the budget more than $5 billion a year.

But the Coalition Government has criticised Labor's policy for unfairly targeting self-managed super funds, and retirees who depend on dividends for their income.

Federal Treasurer Scott Morrison called it the Opposition's bid to "steal" tax refunds from the Australian public.

But how do imputation credits and cash refunds work, and who stands to benefit the most?

Franking and refunds explained

Dividend imputation was introduced by the Hawke-Keating Labor government in 1987, to prevent so-called double taxation of company profits.

This meant that shareholders did not need to pay tax on their dividends, for which the company had already paid tax.

But there was a shift in 2000, when the Howard-Costello Coalition government amended the policy, making it more generous for SMSFs and self-funded retirees — a policy which still exists today.

The effect of this change is that shareholders who pay no tax — or pay a lower rate of tax than the company (30 per cent) — can convert excess franking credits into cash refunds from the Australian Taxation Office.

When companies pay dividends, they can include franking credits (or imputation credits) for shareholders who can then use it to offset their personal tax.

Without franking credits, companies would be taxed their profits, and individual shareholders would then be taxed on those same profits as well.

For example, let's assume a person gets paid a fully-franked dividend of $1,400 (with a franking credit of $600).

This represents the tax the company has already paid — meaning the dividend (before company tax was deducted) would have been $2,000 ($1,400 plus $600).

Currently, this retiree would be entitled to $4,285 in tax refunds, resulting from the franking credits.

Mr Philpot saidif Labor's policy is introduced, this retiree would not be entitled to the $4,285 tax refund anymore — which is significant given his/her limited earnings.

A return to the 'Keating era'

Labor's policy might set up the next election as a "tax battlefield" as it provides "yet another important tax differentiator" between the two main parties, said Professor Bob Deutsch, the Tax Institute's senior tax counsel.

"It is what one could readily describe as the politically low-hanging fruit — easily done with minimum legislative change," he said.

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